Junk Bond ETF ‘Inexplicable’ Price Jumps Continue

By Michael Aneiro

I wrote a Current Yield column on March 9 called “Gravity Pulling Junk ETFs Lower” about how a quirk of bond math augured long-term price losses for high-yield exchange-traded funds, even as those ETFs (namely the iShares iBoxx $ High Yield Corporate Bond Fund (HYG) and the SPDR Barclays Capital High Yield Bond ETF (JNK) kept gaining.

To recap: with the average junk bond price over 105 cents on the dollar, the average bond’s yield at that price is less than its coupon. Over time a bond’s price gravitates toward par value, or the 100 cents that get repaid at maturity. So each year’s yield basically consists of coupon income minus price depreciation. As for how this plays out in ETFs, I quoted Peter Tchir of TF Market Advisors: “The price goes down even though the yield on the bond doesn’t change. That to me indicates that the net asset values on the high-yield ETFs in particular should drift down.”

That hasn’t been happening. Like dividend-paying stocks that drop in value after their ex-dividend date, bond ETFs tend to gradually rise in price each month as the coupon payment accrues and then shed those gains when it’s paid. Tchir says these price moves have grown distorted, and if you strip out this month-to-month cycle, investors have been propping up the long-term core price of these ETFs at levels that are unsustainable, saying these ETFs “really cannot go much higher because of the portfolio they hold.”

Here’s this month’s tale so far. JNK went ex-dividend on April 1, paying a 21-cent dividend, and its price promptly fell from $41.11 to $40.88. By midday Tuesday, it had recouped half of that loss, when (other things being equal) it should take a half a month to see such a rebound. Same with HYG, which went from $94.34 to $93.77 on a 49-cent dividend, but promptly rose Tuesday to $94.18.

Sure enough, both ETFs have subsequently slipped back toward their more “natural” levels, with JNK most recently at $40.92 and HYG at $93.95. But the underlying pattern echoes what’s gone on in recent months, with investors almost too eager to buy on technical dips, propping up long-term prices in the process and preventing any gradual decline. Tchir calls all of this “an inexplicable but tradeable phenomenon.” Certainly one worth keeping an eye on.